Why have living standards stagnated and inequality increased?

Apr 26, 2023
Coin stacking on smiley face and sad face.

Failure to adequately tax mining super profits has greatly damaged the Australian economy.

Living standards have stagnated in the last decade or so, while inequality has increased. This article argues that the two are related and that the concentration of profit growth in the mining sector is an obvious reason why the increase in inequality was so much worse here in Australia than elsewhere.

The rise in inequality

In a recent article, (Pearls & Irritations, 18 April), David Richardson and Matt Grudnoff reported their findings that in the pre-Covid decade between 2009 and 2019, 93 per cent of real economic growth per adult in Australia went to the top 10 per cent of the income distribution and the other 90 per cent of the adult population received only 7 per cent.

Furthermore, this very unequal distribution of the benefits of economic growth between 2009 and 2019 was unusual. In all previous economic cycles since World War II, the bottom 90 per cent of the Australian income distribution got more than half of the total increase in real GDP, and in most cycles they received much more than half and close to their proportionate share.

Also, this unequal sharing of the increase in incomes over the last decade was much worse in Australia than elsewhere. In other major countries and the EU, the top 10 per cent of the income distribution got less than half the fruits of economic growth over the pre-Covid decade. In China the top 10 per cent got just over half, but that was still far less than the 93 per cent in Australia.

We are continually admonished that if we want to lift living standards then we must increase productivity, but the implicit assumption is that the benefits of economic growth based on rising productivity will be proportionately distributed, or close to that. So, why was the most recent economic cycle so different?

Richardson and Grudnoff do not really answer this important question, but I think a recent speech by Ken Henry, the former Treasury Secretary, gives the answer – or at least, helps explain why the distributional impact of economic growth was so different in Australia from other developed economies.

The stagnation in per capita economic growth and living standards

Henry’s starting point is that since around 2005, trend productivity growth has been very low – Henry, describes it as: “the sorts of growth rates only previously recorded in recessions.”

Although productivity growth has slowed in most developed countries, the decline in Australia is worse than elsewhere. In brief, the reason for Australia’s relatively poor performance, according to Henry, was the mining boom and the failure of the authorities to take the necessary compensating policy action to offset the negative impact of the mining boom on the rest of the economy.

As Henry documents, the industrialisation of China resulted in a massive increase in mining exports and sky rocketing prices. Mining increased its share of total exports from between 25 and 30 per cent in 2005 to about 60 per cent in 2022, while manufacturing’s share declined from about 40 per cent to 20 per cent, and everything else (including services) declined from between 30 and 35 per cent to about 20 per cent over the same period.

Not surprisingly there was a corresponding increase in mining’s share of total corporate profits which rose from one-fifth in 2005 to about a half today. Manufacturing profits have fallen from about 20 per cent to less than 10 per cent, and the share of total corporate profits going to the financial services sector, including insurance, has fallen from 20 per cent to less than 5 per cent.

This improvement in mining’s share of profits reflected not only the increase in production but also the increase in international commodity prices, especially for coal, gas and iron ore. This improvement in export prices relative to import prices is called an improvement in our terms of trade. In principle, such an improvement can increase national disposable income, but because the authorities failed to take the appropriate policy action, the mining boom led to a loss of competitiveness and thus a reduction in the profits of other industries.

A country’s competitiveness is typically measured by its real exchange rate – which is our nominal exchange rate adjusted for the rate of increase in our production costs relative to our competitors. And between the end of 2003 and the June Quarter 2011 Australia’s real exchange rate increased by more than 60 per cent – a massive loss of competitiveness for all the rest of the economy other than mining.

As Henry said: “An appreciation of the real exchange rate is a natural macroeconomic adjustment to a positive terms-of-trade shock in an economy that is close to full employment, and in which the fiscal authorities just ‘let it rip’, not releasing the pressure with a resources super profits tax or something similar. Effectively, the real appreciation squeezes other sectors to make room for the sector that is booming.”

Thus, this real exchange rate appreciation and consequent loss of competitiveness is the obvious reason why the profits of non-mining industries shrank, and this loss of profits then led to a decline in their investment ratios. But as Henry says: “Much of Australia’s productivity growth, historically, has been a consequence of capital-deepening, driven by a strong rate of business investment.” Consequently, this loss of investment is the explanation for the stagnation in productivity growth and living standards.

Henry argues that while it might not look a lot, the collapse in non-mining investment, falling from 7 per cent of GDP to 5 per cent, is in fact a lot. “Eventually, that drop in the investment rate of two percentage points of GDP translates into a drop in productivity and GDP per capita of the order of 20 per cent.”

Henry’s argument is perhaps best summarised in two charts showing a strong negative correlation between the terms of trade and non-mining investment and between the terms of trade and productivity growth.

The link between increased inequality and economic stagnation

In short, Henry’s conclusion is that the loss of competitiveness of the non-mining industries is the reason for the stagnation of productivity. But I would add that the concentration of profit growth in the mining sector is also an obvious reason why the increase in inequality was so much worse here in Australia than elsewhere.

The incomes of most Australian households were depressed because with low productivity growth wages were depressed, while the concentration of profits in the mining sector especially benefited the top 10 percent.

The sad thing is that this extreme increase in inequality and low growth could have been avoided if the authorities had taken the appropriate policy action.

As Henry concludes much of the loss of international competitiveness caused by the mining boom could have been avoided had we had the intellectual and political capacity to apply a rational taxation regime to the windfall profits of mining companies.

It is understood that the Treasurer is currently considering increasing the taxation of the super profits of resource companies, but as usual these companies are crying doom and that it will damage future mining investment. The reality is, however, that by definition taxing these super profits only taxes those profits that are higher than necessary to provide an adequate return on investment and should not therefore inhibit that investment.

While on the other hand, as Henry has shown, the failure to adequately tax mining super profits has greatly damaged the Australian economy, and I believe it has also led to a significant increase in inequality.

It is very much to be hoped that the Australian public will get behind an increase in the taxation of mining super profits in the forthcoming Budget. Without it, Australia risks a continuation of the poor performance and increasing inequality experienced in the last decade.

Share and Enjoy !

Subscribe to John Menadue's Newsletter
Subscribe to John Menadue's Newsletter


Thank you for subscribing!